In Defense of a Federally Mandated Disclosure System: Observing Pre–Securities Act Prospectuses

• DOI: http://doi.org/10.1111/ablj.12110
• Date: 01 December 2017
• Author: Brent J. Horton
• Published date: 01 December 2017

In Defense of a Federally Mandated

Disclosure System: Observing

Pre–Securities Act Prospectuses

Brent J. Horton*

INTRODUCTION

The Securities Act of 1933 (Securities Act or Act)

1

created a federally

mandated disclosure system for securities offered to the public,

2

in

response to congressional findings that

1. During the years preceding the 1929 stock market crash, corporate

issuers had failed to provide investors with information necessary

*Associate Professor of Law & Ethics, Fordham University Gabelli School of Business.

LL.M. in Corporate Law, New York University School of Law; J.D., Syracuse University

College of Law. Thanks are in order to my colleague Elizabeth Cosenza for her helpful

suggestions as well as attendees of the 2016 National Business Law Scholars Conference at

the University of Chicago. Fordham University provided grant assistance, for which I am

grateful.

1

Securities Act of 1933, Pub. L. No. 73–22, 48 Stat. 74 (codified as amended at 15 U.S.C.

§§ 77a–aa (2012)).

2

Part I of this article explains the Securities Act’s disclosure requirements in more detail.

For preliminary purposes, it is important to note that the Act required that a corporation

offer securities using a prospectus. Id. § 77e. Further, the Act required that the prospectus

contain twenty-seven items of information, which include name of the issuer; state of

incorporation; location of issuer’s office; name and address of directors, underwriters, and

stockholders; schedule of securities; character of business; capitalization; outstanding

options; capital stock; funded debt; purpose of offering; remuneration paid by issuer to its

directors and officers; estimated net proceeds; price of the security offered to the public;

commissions and discounts to underwriters; net proceeds from previous sales; payments to

promoter; seller and purchase price of property not acquired in ordinary course of busi-

ness; cost of financing; interest of every stockholder holding more than ten percent of any

class of stock; names of counsel; material contracts not made in ordinary course of busi-

ness; management contract, special bonuses, or profit sharing; balance sheet; profit and

loss statement; and proceeds used to purchase another business. Id. § 77aa(1)–(27).

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to determine the worth of the securities they were offering

(or more to the point, whether the security was worthless);

3

and

2. Investors would have avoided worthless securities (estimated at $25

billion) if adequate information was provided.

4

However, some legal scholars have questioned the congressional find-

ing that corporations failed to provide investors with information; these

scholars are referred to as “skeptics,” and those that accept the congres-

sional finding as “conventional scholars.” One prominent skeptic is the

former Dean of the University of Virginia School of Law, Professor Paul

G. Mahoney.

5

In Professor Mahoney’s 2015 book, Wasting a Crisis: Why

Securities Regulation Fails, he calls the idea that pre-Act disclosure was

inadequate “demonstrably wrong.”

6

Other prominent skeptics include

George Stigler,

7

George Benston,

8

and Roberta Romano.

9

3

H.R. REP.NO. 85, 2 (1933) [hereinafter House Report], reprinted in 2LEGISLATIVE HISTORY

OF THE SECURITIES ACT OF 1933 AND SECURITIES EXCHANGE ACT OF 1934, item 18, at 2 (J.S.

Ellenberger & Ellen P. Mahar comps., 1973) [hereinafter LEGISLATIVE HISTORY] (“The flota-

tion of such a mass of [worthless] securities was made possible because ...[a]lluring prom-

ises of easy wealth were freely made with little or no attempt to bring to the investor’s

attention those facts essential to estimating the worth of any security.”); S. REP.NO. 47, 2

(1933) [hereinafter Senate Report], reprinted in LEGISLATIVE HISTORY, item 17, at 2 (“The

necessity for the bill arises out of the fact that billions of dollars have been invested in

practically worthless securities ... by the American public through incomplete, careless, or

false representations.”).

4

House Report, supra note 3, at 2.

5

PAUL G. MAHONEY,WASTING A CRISIS:WHY SECURITIES REGULATION FAILS 3 (2015).

6

Id.at3.

7

George J. Stigler, Public Regulation of the Securities Markets,37J.BUS. 117, 120 (1964) (call-

ing arguments that disclosure was inadequate a “promiscuous collection of conventional

beliefs and personal prejudices”).

8

George J. Benston, The Value of the SEC’s Accounting Disclosure Requirements, 44 ACCT.REV.

515, 517 (1969) (calling the idea that pre-Act disclosure was inadequate “folklore”).

9

Roberta Romano, Empowering Investors: A Market Approach to Securities Regulation, 107 YALE

L.J. 2359, 2373 (1998) [hereinafter Romano, Empowering Investors] (stating that there is “little

tangible proof” that pre-Act disclosure was inadequate); see Roberta Romano, Metapolitics and

Corporate Law Reform,36S

TAN.L.REV. 923, 1004 (1984) [hereinafter Romano, Metapolitics]

(“[M]ost of the required information had been voluntarily disclosed prior to the enactment[]

[of the Securities Act].”); Roberta Romano, The Need for Competition in International Securities

Regulation,2T

HEORETICAL INQ. L. 387, 466–67 (2001) [hereinafter Romano, Need For

Competition] (asserting that pre-Act disclosure was adequate).

744 Vol. 54 / American Business Law Journal

This article will compare

10

the skeptics’ theory that corporate issuers

provided investors with adequate information (that is, that stories of

inadequate disclosure are wrong) against primary-source evidence from

the 1910s and 1920s, specifically twenty-five pre-Act prospectuses

11

from well-known companies like Aluminum Company of America

(ALCOA),

12

Coca-Cola Company (Coca-Cola),

13

and United Cigar

Stores Company of America (United Cigar),

14

as well as many smaller

ventures.

15

Review of these pre-Act prospectuses reveals that—contrary

10

This article’s approach relies on an examination of primary-source documentation, spe-

cifically twenty-five pre-Act prospectuses. The only similar article I could find reviewed a

single prospectus, that of the United Corporation. See Note, High Finance in the ’Thirties:

New Deal Legislation,37C

OLUM.L.REV. 1137, 1170 (1937). It found that “[a] detailed com-

parison between disclosure in 1929 and that which would be required in 1937 ...immedi-

ately reveals that many more of the ‘facts necessary to a sound investment judgment’ will

be presented to the company’s shareholders.” Id. (quoting William O. Douglas & George

E. Bates, The Federal Securities Act of 1933,43Y

ALE L.J. 171, 188–98 (1933)).

11

Before the Securities Act the prospectus was primarily a three- to four- page marketing

document offering the security for sale. See TWENTIETH CENTURY FUND,THE SECURITY

MARKETS 566–68, 567 n.1 (1935). The Twentieth Century Fund explained:

The prospectus in former years contained, first, an invitation to the public to pur-

chase .... It was often garnished with matter obviously intended to stimulate interest

on the part of the public. ... The content of these circulars ranges from relatively

adequate disclosures to extravagant and unfounded promises to investors, poetic

references to climate conditions ...material omissions and outright misstatements.

Id. at 566–67. With the passage of the Securities Act, the prospectus was no longer primar-

ily a marketing document; it became a disclosure document that must accompany all non-

exempt offerings. See 15 U.S.C. § 77e (2012) (requiring the filing of a registration

statement prior to an offering and that all offerings made thereafter be made by prospec-

tus containing substantially the information contained in the registration statement); Id.§

77j (“[A] prospectus ... shall contain the information contained in the registration state-

ment, but it need not include the documents referred to in paragraphs (28) to (32), inclu-

sive, of schedule A of section 77aa of this title ....”).

12

Aluminum Company of America, Prospectus (1925) [hereinafter ALCOA 1925 Prospec-

tus] (on file with author); Aluminum Company of America, Prospectus (1927) [hereinafter

ALCOA 1927 Prospectus] (on file with author).

13

The Coca-Cola Company, Prospectus (1919) [hereinafter Coca-Cola Prospectus] (on file

with author). The entire Coca-Cola Prospectus is included in Appendix B.

14

United Cigar Stores Company of America, Prospectus (1927) [hereinafter United Cigar

Prospectus] (on file with author).

15

See Appendix A (listing prospectuses examined).

2017 / Defense of Disclosure 745